However,
does its traditional role as safe haven guarantee that this
role will continue? Although the yen has attracted risk-averse
capital throughout its lost decade, some believe its mounting
problems are set to turn former currency relationships on their
head.

To
believe yen is a safe haven is to believe the
Japanese economy has no problems: to think that you must be
blind, says Jerome Lorenzi, FX portfolio manager at LNG
Capital.

The
majority of its energy must be imported, it has an ageing
population and a debt almost as large as the US. People say it
has a high domestic savings rate, but that is the only positive
it has.

In recent
months, sentiment on Japan has been improving. The
Bank of Japan (BoJ) has loosened its monetary policy
aggressively, with an ambitious plan to double the money supply
in a 12-month period, which started this spring. This makes the
BoJs planned monetary policy markedly looser than those
of the other big central banks in the medium term.

We
have probably already seen the shock effect of this on
yen, says Ilya Spivak, currency strategist at DailyFX.
It will be a bit quieter now, but yen should continue to
structurally weaken towards the end of this year and next,
assuming the worst does not happen with the
US.

If the
Japanese turnaround continues and inflation expectations are
met under the BoJs easing policy, the BoJ will probably
increase rates, undermining the yens value as a carry
trade play, says Taku Arai, product manager for Japanese
equities at Schroders. However, he notes that, for all the
interest in Abenomics, the US is a bigger driver on yen
than internal Japanese politics.

Most
people agree the yen is likely to follow a downward path in
coming months. The question is how far the government will let
it fall. While a weak yen is good for Japanese exporters, it
hurts the economy as a whole because the country is a large
importer of energy. If dollar-yen hits around 110 or 120, the
ministry of finance would probably tackle the situation, Arai
reckons.

LNGs
Lorenzi agrees 110 is the short-term target, but sees the move
going much further in the long term. Japan needs
dollar-yen to be around 150 in the long term, he says, as
the country seeks to regain competitiveness in a neighbourhood
dominated by countries with cheaper workforces and weaker
currencies.

Soaring
energy costs will be offset by rising wages, he predicts,
adding: They need hyperinflation to erase that debt;
there is no other way.

In the
near term, the biggest risk of yen appreciation comes from
traders continuing to view yen as a safe haven, and fleeing
there as risk aversion sets in, particularly if political
brinksmanship returns in the US.

Although
the US Congress has kicked the debt ceiling can down the road,
there remains a strong possibility of further drama in the new
year, clouding the outlook for yen in 2014.

In that
scenario, DailyFXs
Spivak sees
yen strengthening as the global carry trade is unwound.
If there is another major drop in market confidence,
[carry trades] will be unwound to some extent, which
necessarily means that people will cover their JPY shorts and
the currency will rise, he says.

Lorenzi
believes this outcome is likely, with yen weakening
considerably against commodity currencies, such as the Aussie
and Kiwi, Canadian dollar and Norwegian krone.

There are
plenty of other factors for Japan-watchers to consider as the
government rolls out Abenomics. Recently the debate around
planned increases in the sales tax has been particularly
lively, with
BoJ governor Haruhiko Kuroda expressing the belief that the
economy could withstand a doubling of the tax to
10%.

The
decision to go ahead with an initial rise to 8% from next April
was eventually made at the beginning of this month.

Many
observers, including the IMF, see such a tax hike as an
essential precondition to meeting Japans fiscal
challenges, but the issue remains politically charged and the
Japanese cabinet is divided on whether  and how  to
implement further rises.

These
debates have been set against a relatively upbeat mood in the
Japanese stock market, though the weakening yen has been bad
news for non-Japanese investors in the Nikkei, with returns
eroded in dollar terms.

When
investing in Japan equity, investors obviously had to hedge
away the inherent currency risk, says Frank Jensen, CIO
at Origo Asset Management. Failing to do so for a USD-based
investor would have halved returns for 2012, he
says.

However,
hedge funds and others have been able to play the
Japan-reflation theme, mainly long Nikkei and short
Japanese yen holdings, says Anthony Lawler, portfolio
manager at GAM, the fund of hedge funds manager.

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